A great question! Let’s start by defining what the overhead myth is, for anyone who has never heard that term before. The overhead myth is the false conception that financial ratios are the sole indicator of nonprofit performance. You can read more about it at http://overheadmyth.com.
It’s true: limiting overhead spending can limit a nonprofit’s impact. It can slow down or even prevent progress toward achieving your mission. Before you think about serving your community with services and programs, you need a stable organization. At a minimum, you will need:
- Computers and other equipment
- Office space
Maybe you work at a small nonprofit that operates solely with volunteer staff who use their own computers and work from home. This may work for a while, but let me tell you — it’s not sustainable in the long run. Your staff will need other full-time jobs that they will prioritize over the nonprofit. As your organization grows, you will require more staff hours and will need a paid staff.
You should consider these additional indirect costs you will incur as your nonprofit grows:
- To stay competitive, you need to invest in staff training and professional development opportunities.
- If you operate one or more programs, you will need to hire fundraising and evaluation staff or consultants.
- When your budget gets too large for you to manage, you will need accounting services.
- When you reach a certain level of contributions, or if you are seeking grant funding, you will need a financial audit.
Limiting overhead spending can create an incentive to manipulate the numbers. Some nonprofits may get “creative” with line-item categories in an attempt to show overhead costs as direct costs. More often than not, a nonprofit creates multiple versions of the same budget. In this case, the budget sent to a funder includes only a fraction of the overhead costs and reinforces the flawed notion that nonprofits can operate well with 15% overhead.
When deciding where to put your money, look at the impact of the organization, rather than its overhead. Giving money to organizations that are doing the best job demonstrating real impact and long-term achievement of their mission is the best way to spend your charitable dollars. How much the organization had to spend on overhead to achieve that impact is relevant only when comparing two organizations with approximately the same level of impact.
In the hypothetical scenario below, each of the three organizations provide microloans to entrepreneurs in developing countries and have been in existence for ten years. Which of the following organizations would you rather donate to?
Org 1: can provide evidence of 10% overhead or less but has no evidence of impact. The organization reports only the number and amount of loans and the repayment rate.
Org 2: spends 25% on overhead. They have some evidence of positive outcomes, but no long-term results. In addition to the loan numbers and repayment rate, they report customer satisfaction and short-term outcomes. The results show that 90% of borrowers are happy with the program at the time the loan is dispersed and 75% feel that their household is better off at the time the loan is repaid. This data goes back ten years, but there has been no follow up with previous participants to collect data on the long-term impact of participating in the microloan program.
Org 3: Spends 50% on overhead. They provide evidence of achieving goals and objectives of poverty alleviation, community economic growth, and job creation. There is still a long way to go, but they can demonstrate that poverty in the community has decreased by 10%, new businesses have increased by 50% and 88% of new businesses remain in business after 5 years, and unemployment in the community has dropped from 35% to 18%. They are ready to scale the program to help more communities. They have contributed to best practices in microfinance, and other organizations report improvements to their own programs because of this contribution.
To which organization(s) would you give your charitable contribution? Why? Comment below and let us know what you think.
If you need help balancing your mission and your financial goals, contact Oswald Consulting for a free 30-minute consultation.
Do you have a story about a challenge you have had at your organization? Please share in the comments.